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Corporate Governance in New Zealand

Principles and Guidelines

7.

Auditors

Principle

The board should ensure the quality and independence of the external audit process.

Guidelines

7.1

The board should inform itself fully on the responsibilities of external auditors and be rigorous in its selection of auditors on professional merit.

7.2

The board should satisfy itself that there is no relationship between the auditor and the entity or any related person that could compromise the independence of the auditor, and should require confirmation of this from the auditor.

7.3

The board should facilitate full and frank dialogue among its audit committee, the external auditors, and management.

7.4

No issuer's audit should be led by the same audit partner for more than five consecutive years (i.e. lead and engagement audit partners should be rotated from the engagement after a maximum of five years).

7.5

Boards of issuers should report annually to shareholders and stakeholders on the amount of fees paid to the auditors, and should differentiate between fees for audit and fees for individually identified non-audit work (i.e., separating each category of non-audit work undertaken by the auditors, and disclosing the fees payable for this).

7.6

Boards of issuers should explain in the annual report what non-audit work was undertaken and why this did not compromise auditor independence.

Key findings from consultation

• The role of auditors is important to good corporate governance.
• Rotation of audit firms should not be required.
• Audit partners should be rotated, preferably every five years.
• Auditors should not do work which could compromise their ability to produce independent audit reports.
• Disclosure of fees paid to audit firms should identify specific types of non- audit work.
• Non-audit work should not be capped to a specific proportion of all fees paid to an audit firm.
• Boards should have whistleblower policies and disclose them.
• An independent audit oversight body is not required.

Securities Commission view

External auditing is critical for integrity in financial reporting. To properly perform their role, auditors must observe the professional requirements of independence, integrity, and objectivity. They need to have access to all relevant information and individuals within an entity that play a role in its financial reporting processes.

The board and the auditors are jointly responsible for ensuring that an entity's audit is conducted in the context described above. Good governance requires structures that promote auditors' independence from the board and executives, protect auditors' professional objectivity in the face of other potential pressures, and facilitate access to information and personnel.

The board audit committee has a crucial role in selecting and recommending board and shareholder appointment of auditors, and in overseeing all aspects of their work.

Rotation of auditors is important to promote independence and objectivity over time. However, the advantages of this need to be balanced against the costs that are necessarily incurred when a new auditor is engaged. International practice strongly favours rotation of audit partners rather than audit firms. Although independence would be maximised by rotating audit firms, there are practical impediments and efficiency losses incurred by doing this.

When an audit firm commences a new audit engagement, costs associated with the audit are necessarily higher until the auditor becomes familiar with the entity and its business. Retaining a degree of continuity of auditors will increase the entity-specific knowledge that can be bought to bear in the audit process. Five yearly partner rotation provides a balance between cost and efficiency losses and independence gains, and is in line with international best practice.

Limiting non-audit work that an accounting firm can do for the client entity will help maintain independence and objectivity. There is a diversity of views in New Zealand and internationally on the types of non-audit work that should be restricted, and how this should be done. One core measure is that an accounting firm should not undertake any work for an audit client that compromises, or is seen to compromise, the independence and objectivity of the audit process. Given this measure, and within the framework of relevant legislation and professional standards, boards need to consider this question in the context of their entity. The quantum of fees paid for non-audit work will be a factor in determining independence.

Auditor independence is crucially significant to investors, who rely heavily on this external assurance of an issuer's financial reporting. Boards must be accountable to investors where they allow auditors to undertake non-audit work. This accountability can be achieved by boards of issuers including in the annual report a statement as to why, in their opinion, any non-audit work performed does not impinge on the independence of the auditor. This must be accompanies by disclosure of all fees paid to the auditor, with various types of non-audit work separately identified. This disclosure would be assisted by professional standards relating to disclosure of audit fees and other fees paid to audit firms.

The board audit committee has a crucial role where complaints arise in the auditor-client relationship, or in any other aspect of auditing. The committee should have a defined process for dealing with complaints from auditors, for example over access to relevant information held by management. The committee should also be open to the views of employees or others who believe auditor independence and objectivity is or might be compromised. This includes whistleblowing actions by individuals who act in good faith with respect to external and internal audit processes.

The Companies Act contains accountability mechanisms that allow auditors to report directly to shareholders where reappointment is not sought, or where the entity seeks to remove an auditor. The board is required to permit auditors to attend annual meetings and be heard. Accountability can be enhanced when boards ask auditors to attend shareholders' meetings and to allow shareholders an opportunity to ask appropriate questions of the auditors.

8.

Shareholder Relations

Principle

The board should foster constructive relationships with shareholders that encourage them to engage with the entity.

Guidelines

8.1

Publicly owned entities should have clear published policies for shareholder relations and regularly review practices, aiming to clearly communicate the goals, strategies and performance of the entity.

8.2

Publicly owned entities should maintain an up-to-date website, providing:

• a comprehensive description of its business and structure;
• a commentary on goals, strategies and performance; and
• key corporate governance documents;
• all information released to the stock exchange (for listed entities), including reports to shareholders.

8.3

Publicly owned entities should encourage shareholders to take part in annual and special meetings by holding these in locations and at times that are convenient to shareholders.

8.4

The board should facilitate questioning of external auditors by shareholders during the annual meeting.

Key findings from consultation

• Companies could improve dialogue with their shareholders.
• Companies should facilitate appropriate access by shareholders to auditors.
• Opinion was divided on whether institutional shareholders should always vote on shareholder resolutions.
• Opinion was divided on whether listed companies should publish a formal shareholder relations policy.
• Listed companies are reasonably good at providing shareholders with comprehensive and easily understood financial information.
• Other entities should provide more comprehensive public reporting.

Securities Commission view

Shareholders are the ultimate owners of entities. In general, company shareholders have a right to vote on certain issues affecting the control and direction of their company. In this document we have used the term shareholders broadly to include people with an ownership interest in non-company entities where they have a similar right to vote on entity issues. The rationale for good shareholder relations applies equally whatever the legal form of the entity.

As owners of their entities, shareholders have important rights and functions in corporate governance. Certain matters are reserved for shareholder approval. Boards can take steps to facilitate appropriate shareholder involvement in such meetings and decisions. Entities will be better placed to attract the capital and support they need, and to demonstrate real accountability, if relations between entities and their shareholders are cooperative and mutually responsive.

Good governance requires structures and behaviour that promote good relations through effective communications between entities and their shareholders. Publicly owned entities in particular can enhance this relationship by having a policy for communicating with shareholders and for encouraging appropriate shareholder participation. Steps that can be taken include:

• allocating time and resources to providing clear, plain language explanations of performance, strategies and goals, and identified material risks in the annual and (for listed entities) half yearly reports;
• maintaining websites that have comprehensive up-to-date information on their operations and structures, and an archive of corporate governance documents, shareholder reports, and past announcements and performance data;
• increasing the use of electronic technologies to make information more accessible to shareholders and others, including (where requested) email for distribution of shareholder documents and for responding to questions;
• holding shareholder meetings in locations and at times that are convenient to shareholders, and if appropriate in view of the number and location of shareholders, encouraging participation by teleconference or webcast.
• clearly setting out resolutions for shareholder decision, and encouraging informed use of proxies; and
• providing ready access to auditors for shareholder questions at annual and special meetings.

Institutional shareholders have a vital role to play in corporate governance, by monitoring company performance. If a disclosure-based approach to maintaining corporate governance standards is to be effective, those with voting power in an entity need to make use of their rights to question and challenge the board's performance and its corporate governance practices. Boards can increase accountability by encouraging institutional shareholders to vote on resolutions. Such shareholders, and in particular fund managers who are themselves accountable to public investors, should disclose their voting policies and record to their clients and investors.

9.

Stakeholder Interests

Principle

The board should respect the interests of stakeholders within the context of the entity's ownership type and its fundamental purpose.

Guidelines

9.1

The board should have clear policies for the entity's relationships with significant stakeholders, bearing in mind distinctions between public, private and Crown ownership.

9.2

The board should regularly assess compliance with these policies to ensure that conduct towards stakeholders complies with the code of ethics and the law and is within broadly accepted social, environmental, and ethical norms, generally subject to the interests of shareholders.

9.3

Public sector entities should report annually to inform the public of their activities and performance, including on how they have served the interests of their stakeholders.

Key findings from consultation

• Shareholder interests are paramount but companies should consider the interests of other stakeholders.
• Stakeholder interests include employee, environmental, social, and economic matters.
• Public sector bodies have a wide range of stakeholder obligations set out in law.
• Opinion was divided over whether stakeholder interests should be dealt with by boards or by management.
• Companies should have policies about stakeholder interests.

Securities Commission view

Each entity has stakeholders who contribute to their performance in different ways. Examples include employees, customers, creditors, suppliers, the community and others. Legal obligations and relevant social, ethical, and environmental factors need to be taken into account when considering the interests of stakeholders.

Stakeholder interests have a particular significance for public sector entities with a public good purpose. These entities operate on public funding, and need to pay careful attention to their public stakeholders. While the principal reporting of most public sector entities is to the Crown, public accountability will be enhanced if they also report each year on how they have served the interests of their public stakeholders.

Company law requires directors to act in the best interests of the company (subject to certain exceptions). However, advancing the interests of other stakeholders such as employees and customers will often further the interests of an entity and its shareholders. There is a trend for listed companies to report on how they have affected their stakeholders.

Good corporate governance practices will generally benefit stakeholders. Relationships with significant stakeholders can be improved if they are addressed in specific policies which are disclosed and reported on to stakeholders. In general, we agree with the response to our consultation that managing stakeholder interests should be viewed as simply good business.